5/14/2009 @ 1:37PM

Profit During Panic

Through May 12 the swine flu had infected 5,251 people, resulting in 60 deaths, according to the World Health Organization. Tragic though such figures are, they are hard to square with the massive levels of panic and media attention that’s come along with this new pandemic. But for those with a cool head, the swine flu has also yielded opportunities for investment. Taking a step back, this latest panic should also remind patient investors that times of hysteria can correspond with strong buying opportunities.

First, though, some perspective on what impact the swine flu has had on the world’s financial markets. Despite fears that the flu could put a fragile world economy on ice, so far it’s had little impact on the Standard & Poor’s 500. Since the flu first started to garner widespread attention on April 23, the S&P 500 is up 6.9%.

The pork industry is another story. The American Meat Institute estimates that new pork bans worldwide could cost the U.S. pork industry $710 million annually, or $13.6 million per week. This is despite the fact that the U.S. Centers for Disease Controls has taken pains to explain that you cannot catch the flu from eating pork.

Currently there are 15 nations with official bans on U.S. pork, including Russia, China, Indonesia and Bahrain. But in all fairness, it’s hard to imagine that Bahrain imported all that much pork to begin with. In addition to these outright bans, there are seven nations with confirmed but not official bans, including Albania, Nicaragua and Lebanon.

Although such bans could be bad for the pork business going forward, they haven’t done any real damage to shareholders of domestic pork producers.
Tyson Food
has seen its shares rocket up 10.7% since April 23, and
Smithfield Foods
is up 16.3% in that time. Clearly there was money to be made in other people’s panic.

Although it can be hard to keep a level head during times of hysteria, Vince Farrell, chief investment officer at Soleil Securities, comes armed with historical data that shows that the worst times can mask strong short-term upswings.

For an example, Farrell goes back in time. Since World War II, there have only been two periods in U.S. history where the gross domestic product fell for three quarters in a row. Those periods were: the fourth quarter of 1948, the first quarter of 1949 and the second quarter of 1949 and; the third quarter of 1953, the fourth quarter of 1953 and the first quarter of 1954.

For those who stayed long, the returns came fast and strong. “Remarkably, the market rallied significantly after that first negative quarter and showed a better than 30% return for the one year after that first negative reading,” he says.

The trend continues in smaller form when there were two negative GDP quarters in a row, Farrell adds. This happened 11 times since WWII, and in 10 of those cases the rallied 20% in the year following the first negative quarter.

“My point is that we can try to judge human reaction/overreaction, but as investors we should recognize that we tend to overreact and that is an opportunity.”

Sacha Millstone, the vice president of the Millstone Evans Group at Raymond James, agreed that “people seem to love health scares as news topics in general.” She also adds that most media love a negative headline.

John Osbon, the head of Osbon Capital Management, noted that, although the risk of the swine flu becoming a true plague is small, the potential cost of such a risk is enormous, as proven by the Spanish flu, which killed tens of millions.

So, if you see someone wearing a surgical mask around your town today, you might want to consider going long. Or, failing that, keep your powder dry until the next panic, as it will surely come.

Profiting From Panic

Forbes: Is the market really going to tank because of a very small scale pandemic? Considering that very few people have gotten sick from it, let alone died? Did SARS derail China? Did the West Nile virus derail Wall Street two years ago? No, of course not.

But it is a panic of sorts, or a hysteria. And some people somewhere are surely paying attention to it. But this brings us to the larger question, what sort of role do you feel hysteria and panic has had in bringing down the market? Is it a recession just of fundamentals, or is it a “mental recession” as Phil Gramm said so long ago, when he called the U.S. a nation of whiners? Is it mostly fundamentals with some emotional aspects to it? John, is it an efficient recession? Vince, Sacha is it a recession where emotions play short-term roles, but ultimately have no real power? Or can such fears swamp an actual recovery?

And how can we guard ourselves against hysteria, pandemics and other relatively trivial things?

Vince Farrell: Human emotions will be what they are. The fact is that we tend to discount the bad rapidly, if not excessively. There have been two instances where GDP fell three quarters in a row since WWII. Remarkably, the market rallied significantly after the first negative quarter and showed a better than 30% return for the one year after that first negative reading.

There have been 11 instances since WWII with two negative quarters in a row. Ten of the 11 times the market rallied about 20% in the year following the first negative read. My point is that we can try to judge human reaction/overreaction, but as investors we should recognize that we tend to overreact and that is the opportunity.

Sacha Millstone: My view is that the market may react short term but mostly because the market is oversold and so many traders are expecting a pull back–and wanting a pull back. People seem to love health scares as news topics in general. Most media right now in particular are still wanting the negative headline. I don’t think it matters at all to anyone but a trader.

John Osbon: I am not normally an alarmist, but swine flu is alarming. Just read The Great Influenza by John M. Barry for the story about the modern war by science on the Spanish flu, on an epic scale. 100 million people died worldwide, estimates say. Which is why human-spread flu viruses scare the heck out of the WHO, CDC and lots of others. The pandemic risk is small, but the potential cost is enormous. Flu pandemic is a “white crow” event–nobody alive has ever seen one. Sound like the Black Swan’s evil cousin?

And for the record, this is no mental recession in my opinion, and the whining, and more, is real. For example, 85,000 people lost their homes last month to foreclosure. Almost a million have lost theirs since August 2007. To feel the real impact of that “financial event,” try spending a night homeless yourself. For an even deeper experience, bring your family along for “homeless night.” Foreclosure is an absolute disaster all around, creating enormous financial, societal and personal havoc. Foreclosure is only one cause and consequence of our “great recession.”

Yes, I also believe this is an efficient recession because Dow 8,000 prices in all known bad news (and good, there is some…) that we know. That phrase, “that we know” is the key one.

A sustainable rally is completely possible, for example, if the bad news starts diminishing in size and frequency. The headlines, like GM and Chrysler, stress test, and so on, are not what we should be worrying about, in my view. We already know the headlines, and they are in the price.

Now, “GM makes profit” is a headline I would look forward to in the future! And I would bet we will be well beyond 8,000 if/when it occurs.